RDP 2014-14: The Evolution of Payment Costs in Australia 5. Private Net Costs

The discussion so far has focused on the resources used by each sector to produce a given payment. However, the cost borne by each participant in the payment chain – the private net cost – depends on both the resources used and the transfers between the participants in the form of fees or implicit charges. Analysis of net private costs demonstrates how total resource costs for society are distributed across the participants and is more relevant in the private decision-making of consumers, merchants and financial institutions.[30] For example, consumers' choice of which method to use at the check-out is influenced by a range of factors, one of which is the price they face for using the instrument (Simon, Smith and West 2010). It should be noted, however, that the incentives discussed in this section ignore some of the potential benefits for merchants and consumers of different payment methods. For example, non-cash payment methods are often said to provide consumers the benefit of a greater feeling of security as they reduce the need to carry large cash holdings, a benefit that is difficult to measure and likely to vary across individuals.

As a stylised example of private costs, assume that in processing a payment for a consumer, a financial institution incurs $0.80 in internal resource costs, pays $0.20 to other payment system participants and receives $1 in fees from its customer. Examining only the internal resource costs incurred ($0.80), would result in an incomplete picture of the costs borne by the financial institution. That is, the financial institution's resource costs have been fully offset by the $0.80 net inward transfer that it receives and the institution actually bears no private net cost. Likewise, a merchant will typically face a net outward transfer for a transaction – through, for example, paying their financial institution to process payments on their behalf – so that the merchant's net private costs will typically exceed the cost of the internal resources used in accepting that payment. In turn, however, the merchant may cover their costs by surcharging the payment instrument in question.

The study estimates private net cost for different sectors for the most common point-of-sale payment methods – cash, credit cards and debit cards. As with the previous sections, this analysis is implicitly undertaken at the average size for each payment method.[31]

The majority of the cost of payments is borne by merchants and consumers (Figure 6 and Tables 7 and A8). This pattern is expected; consumers and merchants are the end-users of the payment services and consequently have to compensate the providers of these services. The greater share of the overall cost is borne by merchants, who recoup this cost from consumers in the prices charged for goods and services. Although credit cards have a higher social cost than debit cards, the private net cost to consumers is similar; credit card costs being greatly reduced by the interest-free period, reward points and other services (e.g. complimentary insurance) that credit cards offer (although this is before taking into account interest payments for customers who carry a balance on their credit card). As has been outlined by the Bank in previous regulatory work, the rewards and services offered on credit cards imply more favourable pricing of credit card transactions to consumers at the point of sale, this is likely to raise the share of payments made using credit cards relative to other methods (RBA 2008).

Figure 6: Private Net Costs by Sector
Table 7: Private Net Costs by Sector
Dollars per average-sized transaction
Financial institutions Merchants Consumers
All Issuers Acquirers
MasterCard & Visa credit cards(a)
Resource costs incurred 1.76 1.47 0.28 0.22 na
Net transfer paid −1.22 −0.93 −0.29 1.03 0.19
Total private net cost 0.54 0.55 −0.01 1.25 na
Debit cards
Resource costs incurred 0.29 0.13 0.17 0.20 na
Net transfer paid −0.43 −0.22 −0.20 0.22 0.21
Total private net cost −0.13 −0.10 −0.04 0.42 na
Resource costs incurred 0.19 0.10 0.09 0.27 na
Net transfer paid(b) −0.04 0.07 −0.13 −0.02 0.13
Total private net cost 0.15 0.17 −0.04 0.25 na

Notes: Negatives correspond to transfers received
(a) Does not include interest payments from consumers to financial institutions
(b) Includes seigniorage-related transfers to the Reserve Bank of Australia

Sources: Component estimates are authors' calculations based on: survey data; Craig (2014); Ossolinskiet al (2014); Payments Consulting Network (2014); RBA; RFi Consulting (2014)

5.1 MasterCard & Visa Credit Cards

Of all the payment methods considered, credit card payments have the largest transfers between participants, with the result that net private costs to different sectors are more a reflection of these transfers than the resource cost incurred by each participant. For MasterCard & Visa credit card payments, the net transfer paid by consumers is around $0.19 per transaction, around the same as for debit cards and only a little above that for cash (see Section 5.3) despite the considerably higher overall cost of credit cards compared to these other methods. The low private cost of credit cards to consumers reflects sizeable and largely offsetting gross transfers. To hold a credit card, consumers typically pay annual and other fees; on average, these fees are equal to around $0.84 per transaction. Then at the time of the transaction, consumers receive a sizeable inward transfer from financial institutions at a cost of $0.77 to use the credit card due to the interest-free period and reward points typically offered on some credit card payments. Consumers may also pay a merchant surcharge at the point of sale (of around $0.12 per transaction on average, see Table A8).

Merchants bear considerably higher private costs for credit cards than other methods. Merchants pay large net transfers to acquirers mostly in the form of merchant service fees, although they recoup a small proportion of the cost by surcharging consumers using these instruments.

For merchants, the private costs of credit cards are lower for card-present transactions than for card-not-present transactions. The fees charged by financial institutions for providing card-not-present functionality to merchants are higher than those charged on card-present transactions (Table A4). This is true – although less stark – even after controlling for differences in average transaction sizes between these two different types of transactions.[32] To some degree the higher fees may reflect the fact that card-not-present payments may be more resource intensive for financial institutions (for example, due to greater fraud risks); however, it may also reflect price differentiation across industries rather than across payment channels.

Financial institutions receive a net transfer as the fees received are greater than the transfers paid to consumers. However, there is variation in the net private cost across issuing and acquiring functions due to their different roles in the transaction process. Acquirers receive a net transfer as only part of the fees received from merchants is paid to card issuers through the interchange fee. For issuers, the net inward transfer is less than the resource costs of providing their services. In practice, of course, issuers profit also through the provision of credit; interest revenue on credit card balances has not been included in this analysis.

5.2 Debit Cards

The net transfers recorded for debit cards are much smaller than for credit cards. This partly reflects the fact that debit cards have a lower resource cost than credit cards and so the fees and charges used to cover the financial institutions' costs are lower. In addition, the interchange fees in debit card systems have been capped at a lower level than the regulated credit card systems. As is the case for credit cards, merchants bear the majority of the cost (although again, this is likely to be passed on to consumers in the form of higher prices for goods and services).

The gross transfers to and from consumers resulting from a debit card payment are also smaller compared with those arising from credit card payments; consumers do not gain from interest-free periods, do not generally earn rewards and pay smaller account fees than on credit cards. Another difference is that the financial sector as a whole receives a positive net gain (i.e. pays a negative cost) for debit card transactions.

Across debit card schemes, the net private costs are distributed similarly across the sectors, although the net private cost to merchants for eftpos payments is lower than that for MasterCard & Visa debit payments (Table A8).

5.3 Cash

The private costs of cash are similar to the resource costs of cash for most sectors given the relatively small transfers between participants. To the extent to which transfers take place, consumers pay a net transfer made up of fees to financial institutions (to cover financial institutions' costs arising from cash withdrawals) and seigniorage to the public sector. These are equivalent to about $0.13 per transaction (Table 7). Merchants incur insignificant transfers in the use of cash, resulting in merchants' private net costs aligning with their resource costs.


Net transfers for all participants sum to zero since all outward flows from fee payers are corresponding inflows for the payees. Thus, adding together the participants' net private costs for a particular transaction yields the total resource cost incurred for that transaction. [30]

A range of data sources, in addition to data collected directly from survey participants, are used to estimate transfers and hence private costs. Additional data sources include: the RBA's Retail Payments Statistics collection; the RBA's Survey of Banking Fees (Craig 2014); Ossolinski et al (2014); Payments Consulting Network (2014); and RFi Consulting (2014). [31]

The sample of merchants covered in this study pay, on average, interchange fees below the economy-wide average. Controlling for differences in interchange fees between our sample and the population of merchants increases the level of fees. [32]